Weekly economic briefing: Budgetary sunshine – will it last?

The Weekly Economic Briefing is written by two senior Deloitte Economists, David Rumbens from Deloitte Access Economics in Australia and Ian Stewart Deloitte’s Chief Economist in the UK. They provide a personal view on topical financial and economic issues. Subscribe to receive the Weekly Economic Briefing in your inbox!

Australian economic briefing by David Rumbens

This section of the briefing provides a snapshot of key economic data and issues of relevance to Australia.

Budgetary sunshine – will it last?

The latest edition of Deloitte Access Economics’ Budget Monitor publication presents an outlook for the Commonwealth Budget, including some good news for the federal government (at least in the short term).

Deloitte Access Economics expects that the Budget deficit in both 2017‑18 and 2018‑19 will be smaller than expected at the 2017‑18 Budget – at $26 billion and $20 billion respectively (the official estimates are $29 billion and $21 billion).

The better Budget outlook is due to an improved economic backdrop:

Employment growth has been very strong, with an additional 370,000 jobs created in Australia over the 12 months to September

China’s stimulus has also pumped up corporate profits

The continuation of low interest rates and government policies supportive to housing investors have underpinned Sydney and Melbourne property prices

This means good news for the Government’s largest revenue sources – taxes on both wages and company profits – which account for a combined 60% of revenue.

Looking further out, however, the picture is not as bright.

The 2020‑21 surplus seems safe for now, but we do expect this to be a wafer thin $2 billion (less than Treasury’s estimate of $7 billion). The primary difference here? We expect income growth for workers and company profits to be lower than the optimistic Treasury assumptions, which means the economy won’t grow as much.

Taking a step back, the government’s goal of a return to surplus remains the same, but the chosen route has changed. The 2017‑18 Budget saw the Coalition dump its ‘Plan A’ (Budget repair via spending cuts), and move to ‘Plan B’ (higher revenues to balance the Budget). This now means that five in every six dollars of Budget repair will come from higher taxes, and only one in every six dollars from reduced spending (see the chart below).

Chart 1: Treasury’s expectation for the change in revenue and expenditure over the forward estimates period (as % of national income)

Source: Treasury Budget Papers; Deloitte Access Economics

To achieve the 2020-21 surplus, Deloitte Access Economics projects that 44% of the increase in national income over the next four years will have to go to Canberra. This is a significant uplift considering that government revenues are worth just 25% of the total economy. Granted, some of this comes in the form of policy changes. The new Major Bank Levy and the increase in the Medicare Levy amongst other changes, for example, account for around five percentage points out of the 44%.

That still means it’s largely up to the economy (via higher profit and wage growth juicing the tax take) and Canberra (via politicians fighting the urge to offer personal income tax cuts with an election in sight) to deliver the surplus.

As a result, any forecast Budget surplus needs to come with a giant asterisk attached.

Spending money just keeps getting easier. Internet shopping, electronic bank transfers, contactless and mobile payments are increasingly popular ways of spending. Last year the number of contactless payments tripled in the UK and on-line shopping rose nearly 20%. Digital versions of traditional central bank currencies are in the ascendant in the West.

These digital central bank currencies face growing competition from the private, all-digital, so-called cryptocurrencies. Bitcoin, established in 2009, is the dominant player, but the rash of new currency launches or ‘initial coin offerings’ means it has plenty of imitators.

At the heart of bitcoin is the blockchain, an anonymous, electronic record of all bitcoin transactions. Transactions are processed by a distributed network, not through the banking system as with central bank currencies.

Some bitcoin users distrust banks and want to operate outside the traditional banking network and financial system. Bitcoin’s anonymity appeals to libertarians, those who particularly value privacy and, of course, criminals. Some fear that central banks, with their ability to create money at will, cannot be trusted to maintain its value against inflation. These users see bitcoin, with a fixed ceiling of 21 million of issuance, as a better store of value than pounds or dollars. Finally, the vertiginous rise of bitcoin this year suggests that many see bitcoin as a quick way of making money.

Bitcoin excites different reactions. China, Russia and a number of other countries have put obstacles in its way. Murky governance and its potential as an anonymous means of payment for criminals worry many. The CEO of JP Morgan, Jamie Dimon, has branded bitcoin a “fraud” which will blow up.

Other countries have encouraged its use, most notably Japan which in April recognised bitcoin as legal tender. To its supporters bitcoin could become a stable and trusted global currency, like a latter day Gold Standard or dollar, facilitating trade and commerce.

That would pose problems for central banks. Controlling the price and quantity of money is a vital arm of economic policy and, in the modern world, an expression of sovereignty. It is also a very profitable business. It is difficult to see why governments would want to cede control of money to private currencies.

Practical problems also stand in the way of bitcoin becoming a global currency. Wide fluctuations in its value means that it does not meet one of the definitions of an effective currency – that it offers a stable store of value.

In less than 48 hours last week the value of bitcoin fell from $7681 to $6773. In the last month the value of bitcoin has varied by 70%. Such fluctuations create huge uncertainties for buyers and sellers when transactions do not execute immediately (imagine agreeing to buy a house in a month’s time and finding that the effective cost of the purchase has risen 70%). To be an effective medium of exchange a currency needs to be liquid and widely accepted. Despite stories of property in Dubai being sold in bitcoin, it currently has neither characteristic.

But while central banks may not want to hand over the control of money to private digital currencies, they might want, in time, to invent their own.

A central bank all-digital currency would, in all probability, differ in one important respect from today’s private cryptocurrencies. It is hard to see why central banks would create an anonymous digital currency with all the criminal possibilities that offers. Though a long way off, some central banks have begun to consider what benefits an all-digital currency might bring.

An all-digital central bank currency would eliminate the cost and risks associated with the use of cash. Assuming, as seems likely, it was not anonymous, it could enable the authorities to track transactions, making tax evasion and money laundering more difficult.

An all-digital currency would also enable a central bank to set interest rates below zero – enabling the bank to penalise holders of money in order to stimulate spending. Eliminating cash, and requiring money to be held electronically, would mean that consumers would not be able to insulate themselves from negative interest rates by holding cash. For a central bank in a world of very low interest rates, digital cash would help restore the power of monetary policy.

But what central bankers see as opportunities would look like threats to many consumers. It is not only criminals or tax evaders who might feel uneasy about the state being able to monitor all transactions. Savers would not be happy to be find that they could not hold physical cash and that, if the central bank set interest rates below zero, they would, in effect, be taxed for saving, rather than spending money.

More generally, and despite the rise of contactless and on-line spending, cash remains popular. 2.7 million people in the UK, 5% of all adults, spread relatively evenly across all age groups, rely almost entirely on cash to make their day-to-day payments. It is an important budgeting tool. As London Business School professor, Niro Sivanathan recently said, spending on a contactless card, “anaesthetises the psychological pain that accompanies payment, seducing us into splashing out”.

Cash is universally accepted and, unlike electronic spending, there is immediate certainty the transaction has occurred. Perhaps surprisingly, cash is cheap for retailers to process, with the cost being 0.15% of tender value compared with 0.22% for debit cards and 0.79% for credit cards.

Cash is also valuable as an insurance for the times when technology is either absent or not working. This is not just a matter of a patchy Wi-Fi preventing you buying a sandwich on a train or encountering a cash-only cab in the rain. In the wake of the storm-induced damage to power supplies and communications in September, Puerto Rico became what the New York Times described as a “cash only island”. To cope with the extraordinary demand the Federal Reserve had to fly in more notes and coins. Even in far richer countries some people prefer to store funds outside financial institutions in case of bank failures, emergencies or disaster. To move to an all-digital currency society would need to be confident that digital money would, at all times and in all circumstances, be no less available, reliable and acceptable than cash.

Digital spending is on the rise, but in the UK cash still accounts for 40% of all payments. Contrary to what one might expect, demand for cash is still growing. The total value of Bank of England notes in circulation peaked in the run up to Christmas 2016 at over £70 billion, an increase of 10% on a year earlier. Most countries, including the US, Canada, Australia and the euro area are seeing growth of 5 to 10%. The outlier is Sweden where the value of notes has been falling for a decade.

Digital spending is rising, led by younger, more affluent and urban consumers. But we seem some way off a world of all-digital money. Cash remains too useful for too many people. To paraphrase Mark Twain, reports of the death of cash are greatly exaggerated.

PS: Recently published data from the Office of National Statistics show that over the last 20 years the UK has had the lowest levels of investment relative to GDP of any of the 35 advanced, OECD economies. UK investment has averaged 16.7% of GDP over the period. South Korea, which tops the list, averaged 30.8%. Some of the UK’s poor performance is due to meagre government investment. The link between investment and productivity is not straight forward but these numbers suggest that the UK has not been investing enough.

PPS: Conservative MP and former minister Nick Boles released a book last week advocating an end to “the age of austerity”. The timing is significant as the Chancellor prepares to deliver the budget in two weeks’ time. Mr Boles urged the Chancellor to scrap his deficit reduction plan and unveil a “massive boost” in public investment. He said that austerity was the right policy when the deficit stood at 10% of GDP, but it would be acceptable to maintain the current 2.6% level indefinitely and prioritise public investment.

OUR REVIEW OF LAST WEEK’S NEWS

The FTSE 100 ended the week down 1.7%, at 7,433.

Saudi Arabia’s Crown Prince, Mohammed Bin Salman, initiated a crackdown on corruption in the Kingdom, arresting a number of high profile business men and princes.

International economic briefing by Ian Stewart

Economics and business

Local elections in the US saw Democrats vastly outperform expectations across the country, in what the FT reported as “a striking rebuke of Donald Trump”

US interest rates are likely to rise from a current 1.25% to 2.25% by the end of next year according to Fed rate setter John Williams

Germany’s Council of Economic Experts warned that the economy is in danger of overheating as a result of low interest rates and above trend growth

Germans will in future be able to register as neither male nor female but a third option after a landmark ruling from the country’s constitutional court

According to the NIESR think tank UK growth has accelerated and is likely to rise to 0.5% in Q4, the strongest rate this year

A Bank of England survey showed UK businesses expect to increase staff pay over the next year as it becomes increasingly difficult to retain employees

56% of UK households own a pet, down from 63% 5 years ago, say retail analysts Mintel which blames the decline partly on the increase in renting. Ownership of pet fish took the biggest dive, down from 17% of households in 2012 to 10% today

Uber lost its appeal against the UK’s ruling that it should treat its drivers as “workers” who are entitled to the minimum wage and other benefits

The FT reports that electric cars and their batteries are increasing in size, and that some now emit more carbon over their than smaller petrol/diesel cars

Google tested the first truly driverless car on the streets of Arizona, previous tests had humans on board in case of emergency

Deutsche Bank chief, John Cryan hinted at job losses as he pointed out that most of the bank’s major peers employ half the 97,000 staff that Deutsche does

HSBC promised $100bn in funding for projects that tackle climate change by 2025

Brexit and European politics

The European Commission raised its forecasts for Spain’s 2017 and 2018 economic growth despite the constitutional crisis in Catalonia

The FT reports that Theresa May is set to raise the €20bn offered as Brexit payment to the EU

The European Commission said it is “essential for the UK to commit to ensuring that a hard [Northern Irish] border is avoided, including by ensuring no emergence of regulatory divergence from those rules of the internal market and the customs union”

The Democratic Unionist Party rejected the idea of any special arrangements after Brexit that would maintain the EU’s regulatory powers in Northern Ireland

Dublin called for a transition period of up to 5 years after the UK leaves the EU in March 2019

Britons are happier and more satisfied with life since the Brexit vote despite a squeeze on real incomes from higher inflation, according to the Office for National Statistics. The ONS attribute the improvement partly to rising employment * A fifth of UK companies involved in EU supply chains have struggled to secure contracts that run after March 2019, according to the Chartered Institute of Procurement and Supply

And finally…

In 2010 a software developer wanted to know whether he could order a pizza with the then-little-known cryptocurrency bitcoin. He posted a request for two pizzas on a forum and offered 10,000 bitcoin in return. A British user took him up on the offer. In today’s money, the pizzas cost the developer £50 million – cheesed off

David Rumbens is a Partner within Deloitte Access Economics. He is a macroeconomist with extensive experience in applied economic and quantitative analysis of the Australian economy, along with considerable experience in labour market analysis.

Ian Stewart is a Partner and Chief Economist at Deloitte where he advises Boards and companies on macroeconomics. Ian devised the Deloitte Survey of Chief Financial Officers and writes a popular weekly economics blog, the Monday Briefing. His previous roles include Chief Economist for Europe at M...

Ben a manager in the macroeconomic policy and forecasting group within Deloitte Access Economics. Ben is an expert in Budget policy and is a key author of Deloitte Access Economics’ Budget Monitor publication. Ben also has experience advising public and private sector clients across macroeconomi...

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